Popitzs Law

Decentralization around the world has attracted much attention from economists, political scientists, policy makers and politicians. The virtues and dangers of decentralization have been discussed, as well as the political dynamics that make the process of decentralization possible.In the debates over decentralization, most discussions concentrate on how to devolve expenditure and design transfer systems to subnational jurisdictions. The construction of tax authority, and the conformation of revenue systems, in which local, state (provincial) and federal (central) governments play various roles, is often relegated to a normative discussion about what taxes should be collected by which level of government. Popitzs Law and the incentives for fiscal centralization Specialists in public finance have long noted the crucial link between expenditure andrevenue collection, through the so called benefit principle. The prevalence of fiscal arrangements in which revenue is centrally collected, while expenditure is decentralized, breaks this connection, making local politicians able to spend resources they did not collect directly from their citizens. Popitz believed that fiscal centralization would undermine federalism, since as the financial authority of the member state is weaker, the federal elements are abandoned and unitarism is achieved (1927:347; my translation). He also noted that this process was as much political as financial: the political preponderance of tasks leads to the central state (p.348). Popitz himself, as a public servant of the Reich, proposed wide reaching reforms that transformed the system of fiscal relations in Germany into a highly equalizing system of transfers during the 1930s (Newcomber, 1936). Popitzs argument was not about the expansion of government involvement in the economy, and hence the size of the central government, but rather about a structural transformation of government activity that accompanied growth and development, in which central power would be used to control and limit local authority Is Popitzs law empirically correct? Were state and local governments ultimately bound to lose their authority to tax and directly collect revenue? The empirical evidence that has been marshaled to this issue is a comparison between Germany and Switzerland, which suggests that Popitzs law holds for Germany, but is incorrect for Switzerland (Blankart, 2000). The incipient trends towards centralization Popitz observed in Switzerland in the 1920s were reversed in the 1950s (Jarach, 1966). No systematic effort has been made, however, to measure the degree of tax authority exhibited by local and intermediate authorities around the world throughout the course of the 20th century an exploration of the determinants of Popitzs law in order to gain greater insight into the construction of national fiscal authority, this section tests structural and institutional determinants of tax centralization. While this paper does not offer a full theory of fiscal centralization, I explore four hypotheses drawn from the literature. First, it is possible that decentralization is a consequence of the fragmentation of political power. At one extreme, a monolithic

authoritarian ruler would not allow for tax decentralization, because the aim of such ruler, consonant with the framework developed by North (1981), would be to monopolize all sources of revenue.14 However, rulers, even authoritarian ones, usually face challengers, who may compete with them for the control of revenue. Hence, to the extent that political representation is fragmented, and politics is played out in a democratic fashion, Second, tax collection always confronts transaction costs (Levy, 1988; Cheibub, 1998). Fiscal decentralization can be a device through which national rulers reduce transaction costs, by delegating collection to the levels of government which are closer to citizens or subjects, and hence most likely to overcome monitoring and compliance problems..Third, as Popitz (1927) suggested, the process of economic modernization might produce fiscal centralization. Poor countries would be characterized by fragmented, overlapping and decentralized tax systems; while more modern countries should presumably be able to collect taxes in a more centralized fashion, Finally, it is possible that tax centralization is a product of the colonial heritage and the imitation of institutional and organizational practices becoming diffused among countries, depending on their relationship with other countries in the international environment. In a rather influential thesis. Did democracy and federalism play a role in the process of centralization in the course of the 20th century? To answer this question, I explore tax centralization as a long term process, over six decades. The corresponding measure of centralization was 75 percent for unitary systems, a figure that increased 10.8 additional percentage points throughout the period. Initial levels of centralization varied across the world depending of the type of territorial organization they had in 1935, and also accounts for systematic differences in the degree to which they became more centralized through time. Democracy, as measured by the years during which a country was democratic in the 60 year interval of the estimation, does not temper the forces of centralization. There is no evidence that democratic (or authoritarian) countries differed in their trend towards centralization in the 20th century There is no clear evidence suggesting that centralization is related to modernization effects, beyond convergence in levels of centralization that are captured by the CEN35 variable. This does not rule out that economic development might have an impact on centralization through this convergence process, but there is no independent effect that would make, for example, underdeveloped or late industrializing countries likely to centralize more rapidly than developed countries. Federalism, on the other hand, yields statistically significant and strong effects in arresting centralization the empirical analysis suggests that the process of centralization can be characterized as one in which countries have converged to similar levels of decentralization: in the same way as the most highly decentralized countries have become more centralized, countries in which tax authority was mostly concentrated in the national government have converged to greater decentralization. The prevalence of centralization is probably driven by structural factors related to the expansion of world trade.